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Raising MPG Standards: The Second-best Solution to a Gas Tax Increase

It got surprisingly little press coverage given the degree to which it will affect our lives (thanks, pesky world economic meltdown), but in case you missed it, the Obama administration recently worked out a compromise with the major automakers that will dramatically raise the corporate average fuel economy (CAFE) standards.

The new regulations mandate that the mix of new cars sold in the year 2025 must achieve about 54.5 miles per gallon (though if you read the fine print you’ll see that credits for various other green innovations mean that actual fuel economy will be more like 40 MPG.) For reference, the auto fleet currently on the road gets about 27 MPG. It’s a well-done agreement that will help avoid well-done citizens as global warming accelerates.

Before proceeding, let me note that I am strongly in favor of this policy. The problem of excessive fossil fuel use in transportation is multidimensional: if the issue of global warming doesn’t move you, the thought of Hugo Chavez and Mahmoud Ahmadinejad using our own hard-earned dollars to tweak our geopolitical noses should.

However, it is worth noting that raising CAFE standards is what political scientists and economists call a “second-best” solution; we could be doing considerably better if we thought all of this through more clearly.

This is not because CAFE doesn’t work; it does. In 1975, a few years before CAFE was implemented, average MPG for new cars and light-duty trucks was 13.1. In 2010 it was 22.5. Can this be attributed to CAFE? To a large degree, yes, as this graph makes clear:

CAFE standards were aggressively increased from 1978 to 1984, and, as the chart above shows, fuel economy responded. However, from 1985 until 2007 CAFE standards were no longer raised meaningfully—and MPG flatlined. The table makes it pretty clear that the CAFE standards created a floor under MPG for a 25-year period, when low gas prices (remember those?) rendered consumers otherwise indifferent to fuel economy.

So what’s the problem with raising CAFE today?

There is a long history of debate on whether “command and control” regulations (like raising CAFE standards) are a good way to bring about change. The other option is the use of price signals—which in this case would be increased fuel taxes—to influence consumer behavior.

Regulations do have some attractive features. For example, we can directly target what, when, and how much improvement we are getting. If we want fuel economy of 55 MPG, we can decree and achieve it with greater certainty than if we try to monkey around with prices.

However, in theory at least, economists generally prefer to do things with price signals as opposed to regulatory standards. Why?

Price signals inflict pain on consumers, but let them figure out what form they want to take it in. They in turn force producers to respond to their (altered) demand, but allow producers leeway in how that demand is met. This allows consumers and producers to change behavior in the most efficient possible manner.

Instead of CAFE, why not just raise the gas tax and let drivers figure out whether they want smaller cars, lighter cars, less powerful cars, more expensive cars, shorter-range cars, or, crucially, cars that are just as heavy, powerful, and cheap—but which get driven less?

This raises the true problem with CAFE. It misses out on a potentially key part of the solution to reducing fuel use: driving less. In fact, ironically, increased CAFE standards will have a perverse and unwelcome effect; better fuel economy will increase the fixed cost of driving (i.e. vehicle prices) but will actually reduce the marginal cost (i.e. fuel expenditures). To a degree, less thirsty cars will actually cause people to increase the number of miles they drive (as I’ve written about here).

With increased gas taxes, on the other hand, less driving will be part of the consumer’s toolkit. Some who absolutely need vehicles with poor fuel economy will have the option of avoiding the tax by driving less instead. As long as their fuel use goes down, why not give them that choice? Greater economic efficiency would result. In fact, the Congressional Budget Office ran the numbers in 2004 and found that cutting fuel use through taxes was considerably cheaper in the long run than raising CAFE.

Reducing driving through a higher gas tax would have other important benefits that improving fuel economy does not, like congestion relief and accident reduction. I personally am more sympathetic to automobility than most of my colleagues in my field, and I have faith that technological ingenuity will deal a powerful and probably decisive blow to our emissions problems. But raising the price of driving above current levels is pretty much a no-brainer; it has support that stretches across ideological lines in the transportation field, even among those like me (and even among carmakers such as GM) who do not see exchanging cars for biodegradable pogo sticks as the only possible solution to our transportation problems.

Another advantage of a gas tax increase is that it would start working today. Since the car fleet takes so long to turn over (according to the US Department of Transportation, automobiles these days stay on the road an average of about 12 or 13 years), it will be a very long time before the new CAFE standards actually translate into meaningful changes in emissions. But increasing the gas tax would have immediate effects.

(Some might object that fuel taxes are regressive and would hurt the poor, and to an extent they would be right. However, the rich drive considerably more than the poor, taking some of the stink off. And paying for many of the new fuel-economy technologies CAFE will result in will be regressive too.)

Thus CAFE might be a second-best policy: good, but not as good as we could have. Then why are we using CAFE while gas taxes stay laughably low by developed-world standards? Obviously, and understandably, because voters hate taxes. If anything, the political winds are blowing towards a lower gas tax, not a higher one.

Alan Moore

August 15, 2011 @ 5:37pm

A first year stat's student would call foul on your cause-effect relationship claims.

"Can this be attributed to CAFE? To a large degree, yes, as this graph makes clear"

That graph shows NOTHING other than they both went up at the same time. You present no evidence that one caused the other. It is possible for consumer demand for higher MPG effected the auto industry, that tightened budgets caused the increase, or that auto companies attempting to differentiate themselves from other auto manufactures caused the increase. There are WAY to many variables that you have't tested for for make this claim.

I appreciate the analysis that you have done here in saying price side demand could better encourage higher MPG standards, but your claim of cause-effect relationship is pitiful.

James

August 15, 2011 @ 7:20pm

But you forget that a lot of us were actually around in those days, and were able to examine all those other variables for oourselves.

Steve

August 15, 2011 @ 5:50pm

There is a lot more talk about fuel prices these days than there is real price sensitivity. Based on the current fleet average MPG and a roughly12,000 miles of driving per year average, increasing fuel prices by $1 per gallon will cost the consumer less than $40 per month. Because the price is so low, compared to other expenses, there is little sensitivity, so the oil companies have been able to garner huge relative profits. Increasing taxes will price fuel at a point of higher sensitivity, forcing oil companies to be more price competitive.

Therefore, the amount of the actual price increase paid at the pump will probably be significantly less than the total increase in taxes. This would be a net win for consumers, either in reduced taxes elsewhere or increased services, such as alternative transportation.

Gary L.

August 15, 2011 @ 6:40pm

"Based on the current fleet average MPG and a roughly 12,000 miles of driving per year average, increasing fuel prices by $1 per gallon will cost the consumer less than $40 per month."

This is predicated on the assumption that the only fuel cost a consumer incurs is the cost of adding fuel to their own tank. This, of course, is incorrect, since increased fuel costs increase the cost of almost all goods. That said, I agree with you in principle. One way or another, increased fuel costs will cause consumers to demand increasingly efficient vehicles. I see no sense in sending that windfall to dictators with questionable (at best) intentions, when the same shift in consumer demand can be achieved through methods that keep those dollars here.

I like to think of it as a "Cash for Clunkers" type policy, only better designed.

Clancy

August 15, 2011 @ 5:55pm

I think we need some kind of “arms reduction agreement” where liberals agree that some regulations are bad and conservatives agree that some taxes are good. If we can do this, we will be on the road to a more efficient government that does more to make life better and costs less.

Gary L.

August 15, 2011 @ 6:45pm

Was the debt ceiling showdown the Cuban Missile Crisis in this scenario?

Skip

August 15, 2011 @ 5:59pm

With the way our political system works, with its rewards for politicians who cater to the fickle winds of voter opinion, controlling behavior by increasing direct costs to voters will rarely work. No matter how much better the solution, increasing a direct voter cost is nearly always less popular and therefore dead-on-arrival for politicians. It's too bad, but as long as we tie political success only to voter opinion, we're stuck with less-efficient regulation.

There's also the issue of entrenched interests fighting against the regulation, so often we end up in a position where politicians fail to solve the problem entirely. They can't raise costs if they want to keep voter opinion, and they can't regulate without upsetting the entrenched interests and losing influence and campaign money. Thus the long delay in getting tougher regulations in place.

All this is a pretty sad commentary on how our political system works, but unfortunately changing it has the same restrictions. Either unpopular or defeated by the entrenched interests.

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cackalacka

August 15, 2011 @ 7:34pm

Yep, a higher fuel tax can smooth supply/demand fluxuations, repair bridges in Minnesota (and maybe build a few more) and are infinitely more sensible than cafe or the proposed 'GPS tax' (tax on mileage.)

It is possible for responsible tax policy to be phased in so it doesn't crush the working poor, and it is possible for taxes to be a sensible instrument to determine rational behaviors.

Damn shame that half the political infrastructure here in the states has sworn a blood oath to Grover Norquist and is plays policy like some UWF cage-fighting. Up-and-comers in other parts of the world will continue to play the long game; meanwhile we're not paying the bills, rewarding shoddy domestics (that whinged up a storm about CAFE) while telling Johnny Refinance, "Sure you can finance that SRT8, it will have no consequences for your checkbook/neighbors safety/air; after all it's got a HEMI!"

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Mike B

August 15, 2011 @ 6:00pm

It;s not a good solution when it comes to actually paying for the roads people use. In fact higher millage will only make the problem worse as cars can travel further on their paltry 18 cent/gal tax payment. :-(

Mark Brucker

August 15, 2011 @ 6:05pm

Excellent points. I'd add that the increased driving will increase a lot of environmental problems. Not only will it reduce the benefits that would occur for global warming with a gas tax. It will almost certainly increase air pollution, including air toxics, water pollution, and hazardous wastes. It will also, as you noted, increase collisions. Which means more deaths, injuries, pain and suffering, etc. And the increased mileage and wrecks will increase costs for road maintenance, for emergency services, and health care.

Deron

August 15, 2011 @ 6:21pm

Why not apply a license plate tax based on the weight of the vehicle, and push towards toll roads that charge more for peak times?

At least it could be argued that users would be bearing the cost of wear and tear.

James

August 15, 2011 @ 7:17pm

"...why not just raise the gas tax and let drivers figure out whether they want smaller cars, lighter cars..."

Because drivers do not get to choose what kind of cars they drive. They can only choose from what the auto industry is willing to produce. The American auto manufacturers are - and have been for half a century - only interested in building large, heavy, unresponsive vehicles (despite unmistakable market signals starting from the original VW Beetle), and spending uncounted billions on advertising in order to persuade the hard-of-thinking majority that those are what they really wanted all along.

Tuckster

August 15, 2011 @ 7:23pm

The implications for governmental control are also vastly different between CAFE and gas taxes. The externalities of gas consumption would rationally be imposed by the government. Direct industry manipulation is a horrible idea, however, as even an agency of car experts can't predict the future of the car industry (thank god--look what happened in the private market). It's like price-fixing.

Chris

August 15, 2011 @ 7:44pm

Did you happen to think of anyone outside the northeast?

Most places in the US don't have mass transit and couldn't have effective mass transit even if the demand was there. In all but the few places that do have effective mass transit raising the gas tax would only have the effect of making people poorer. It wouldn't reduce the numbers of miles driven in a meaningful way due to there not being any other alternate form of transportation available. If the gas tax was particularly high for a long enough period of time it would potentially help to change patterns in where people live vs work, but that would take a lot longer than the time it would take to replace cars with the new CAFE standard.

James

August 15, 2011 @ 9:14pm

"...raising the gas tax would only have the effect of making people poorer."

Not in the long term, and not if you think it through. Suppose Joe Average now drives 10K miles year in a vehicle that gets 25 mpg, with gas at $4/gal. That's $1600/yr. Say a hefty gas tax raised the price of gas to $6/gal, and when Joe replaces his vehicle (which at some point he would do anyway, regardless of gas prices), he chooses one that gets 50 mpg. (Which is, in the real world, probably cheaper than a car that gets 25 mpg, too.) So he's now paying $1200 a year to drive the same 10K miles, and is richer by $400 a year.

robu

August 15, 2011 @ 7:44pm

Why is it that the government always tackles the supply and not the demand? Drug War-> go after the supply (cartels, smugglers, etc.) and ignore the demand (drug users). Aren't we repeating that with CAFE->go after the supply (auto companies) and ignoring the demand (car owners/purchasers)? By enforcing a CAFE number, aren't you just guaranteeing that the car companies have to sell more unprofitable vehicles for every high profit vehicle (remember that it is an average....)?

Alia D.

August 15, 2011 @ 8:29pm

I’ve hear it argued that one effect of CAFE is forcing families that needed the option of seating up to 7 or 8 people from station wagons, which count as cars under CAFE, to SUVs which don’t count as cars under CAFE, thus resulting in a substitution of a less fuel efficient vehicle for a more fuel efficient car. Even if SUV and mini vans were pooled with cars I would speculate that some of the demand for larger vehicles is being driven by the desire to facilitate carpooling. And two smaller, more fuel efficient, vehicles might end up using more gas then the same trip in one larger vehicle. So using regulation to force up average fuel efficiency per car could actually force down the fuel efficiency per transportation tasks in certain scenarios

Joshua Northey

August 15, 2011 @ 9:08pm

40% of miles driven are single occupant. 7 or 8 person families are fairly uncommon.

All the 7 and 8 person families can keep their SUVs or station wagons, or dump trucks if we can get the commuters to use a vehicle that is more appropriate for their needs (something the size/power of a motorcycle).

I bike to work through rush hour and at rush hour 85% of the cars are single-occupant and probably 95% of them are not carrying enough cargo to justify the size vehicle they are using.

A huge over-engineering of the problem of getting from A to B. Each person surrounded by hundreds of pounds of metal and several cubic feet of machine, when they have 1 200lbs person and a handbag 9 times in 10.

Radhik Hairam

August 15, 2011 @ 8:57pm

Fuel consumption is highest in USA due to heavy utilization of cars! Elementary, yes; but the aspect I wish to emphasize is that most of them are occupied by one person who drives himself/herself. Why this extravaganza? Small cars with only two seats may be a solution, with higher mileage true; but they will be v light and cannot assume high speeds witnessed now! Majority of work force use cars singly and that leads to more usage of gas, as also parking space and allied problems; WHY not introduce Metro Bus Service in Major cities and ensure that is used by office goers, by some suitable means; tax their cars more IF they are used for office trips ! Difficult? Introduce Office transport at regular intervals so that flex time operations are also rendered feasible and employees are forced to use it to save money on gas and thereby help green peace movement and reduce consumption; May appear too simple, but surely deserve to be given a thought; MUST reduce traffic or road for results!

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IE

August 15, 2011 @ 9:38pm

Increase the gas tax, but lower the income tax (or send out tax rebates), making it tax revenue-neutral.
That would decouple the gas tax issue from the usual more taxation vs. less taxation debate. That's the only way to make politically acceptable in the current environment.